Expect Government Spending to Goose Stocks

Today I want to talk about the short-term outlook for the market, but before I do, let me say that it still amazes me to listen to the gross contradictions coming out of the mouths of our lawmakers. If I thought they had a clue, I'd ascribe these comments to a perverted cynicism, but I don't think they have a clue.

Take, for example, Rep. Chris Van Hollen (D., Md.), the top Democrat on the House Budget Committee. He says that budget cuts would be "bad for job growth." Yet in the very next sentence he says "there's no disagreement on the need to reduce the deficit." Well, budget cuts are deficit reduction, so how do you say one thing is bad, yet the other is good? The statements are not only contradictory but completely irrational. That's the real frustration in all this. We are in the grips of an irrational dogma, and I've often said that an irrational belief system is like a disease within a body: If you don't eradicate it, it can kill you.

That's enough of that. Let me move on.

This morning's report on advance retail sales has some people thinking that the payroll tax increase that went into effect at the beginning of the year is starting to bite. You may think the payroll tax cut that was enacted in 2011 didn't make much of a difference, but it did -- it made a huge difference. That small reduction in the FICA tax added more than $140 billion to private wages and salaries, which equates to nearly a 1.0% addition to GDP.

Unfortunately, the reverse is now going to be true. The rise in the payroll tax will remove that much income, causing it to be a drag on the economy, all else being equal. And remember, this is even before we see the cuts that will occur under sequestration.

Why, then, is the market doing so well in the face of another fiscal cliff, a real one, and one that we'll probably go over this time? It's all about the money. What I mean is, if the government is providing enough money and demand through sufficient levels of deficit spending, then incomes, the economy and the markets will be supported.

One of the things I like to look at is the Treasury's monthly balance. In the past, I've explained that deficit spending adds to the income and savings of the private sector by definition. All those dollars spent by the government have to go somewhere. Someone's got to earn them. And if the government spends more than it collects in taxes, then it adds to the total level of financial balances in the economy.

Last October and November, we saw a huge, $300 billion net injection of spending. That's really, really, big, as the "normal" deficit (net injection) has been running at about $90 billion per month. For these two months combined, however, it was nearly twice that. It's no wonder the market climbed higher.

In December and January, that pattern reversed. The federal government ran a tiny deficit of $1 billion in December and a small surplus of $2.9 billion in January. Therefore, no net injection. Consequently, the S&P 500 was up only about 2.4% in January.

Things are now flipping back to the spending side. In the first 11 days of February, total net injections have totaled $83 billion. That's huge, and it means that the banking system and economy are flush with cash. It portends an improvement in the economic data and an almost certain ascension of the Dow and S&P 500 to new, all-time highs before this rally has any chance of being threatened by the spending cuts that will hit in March. My advice: Get long, be aggressive, and enjoy the ride while it lasts.

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